Ignoring the effect of disruptive technology at our peril
By Michael Baxter
We are close to the end of a record. Interest rates across much of the developed world have been sitting at record lows – in most cases for more than half a decade. In the UK, interest rates have been at 0.5 per cent since 2009. Things are set to change, however, with the Fed likely to announce a hike in interest rates later this year, and the Bank of England’s governor Mark Carney hinting at a rise in UK rates in January 2016. What about the long-term prospects? What role will disruptive technology play?
A couple of years ago, McKinsey argued that we are set to enter an era of much higher interest rates. McKinsey was attempting to dig deep, and look at the underlying forces that determine interest rates in the long-run. It was right to do so, but it may not have fully factored-in the likely impact of technology.
In the long-run, central bankers are like flotsam and jetsam. They can set interest rates in accordance with the circumstances of a particular time, but in the long-run the factors that determine the circumstances are the ones that matter.
In the long-run what matters is output, potential output, demand, savings and investment. Let’s say there is a rise in savings, but no corresponding rise in investment. Higher savings will push down on interest rates. These higher savings either fund a corresponding rise in debt across other sectors of the economy, or they drain out of the economy like water from a leaky cauldron, pushing GDP down and possibly creating a recession.
Those who say the world is awash with debt overlook the other side of the equation. It is also awash with savings.
This is not a new problem. It has been with us for a decade or more. There are multiple causes. They are:
· China’s policy of maintaining a cheap currency, leading to Chinese money flooding into western money markets.
· High savings in China, Japan, and much of Europe.
· A rise in corporate profits to GDP at the expense of wages to GDP, without a corresponding rise in investment.
This begs the question why? One factor has been demographics. Maybe the other has been technology.
In its report, Farewell to Cheap Capital, McKinsey looked at changes in China, a shift in its policy towards its currency, and the rebalancing of the economy away from investment-led to consumer-led growth. China’s government wants to see its consumers spend more, which in turn will lead to a surge in imports into China. McKinsey argues that as China contributes more towards global demand, global demand will rise, leading to worldwide pressure on interest rates and inflation.
At the same time, as emerging markets – such as the economies of South East Asia, including India and Indonesia – expand, they are likely to adopt a very different economic model to the one China has applied over the last decade or so. India and Indonesia are likely to demand more foreign capital to fund investment. This will push upwards on global interest rates.
These developments are largely positive. It will be a good thing if the global economy sees growth in demand. However, a side effect may be higher interest rates, which will not be good for those who are highly indebted.
Pushing against the forces that McKinsey describes, we have demographics and technology. This century will see a great change in the population map of the world.
As this chart shows, outside Africa the fertility rate is either below the replacement level or very close in every region of the world. This means that once the current generation of newborns reach old age and then die, populations should fall across Europe, Asia and both North and South America. The population is already falling in Japan, and is either falling or close to doing so in Germany and Russia. Experts expect it to fall in China by the end of the decade after next, and even fall in India towards the end of this century. This may seem like a long way off, but bear in mind that a population ages before it declines. An ageing population is associated with higher savings, which is why interest rates have been low in Japan for so long. We are seeing this force at work across the Eurozone now.
This means that over the next few decades, we will see two conflicting forces at work. There are the forces described by McKinsey pushing up on rates, with demographics pushing in the other direction.
A third force – iDisrupted on Amazon – may determine the outcome.
For one thing, disruptive technology may lead to acceleration in the process we have seen in recent years – the emergence of massive companies, with large cash reserves and a low contribution towards employment. The truth is that, relative to their size, the likes of Google and Facebook each have a tiny workforce.
We are seeing the emergence of an economy in which the owners of capital and that small percentage of the workforce who help design and make the next generation of technology products, are owning increasingly more wealth. Over the last decade or so, we have seen corporate profits to GDP rise, accompanied by a ballooning corporate cash pile. This has helped push interest rates down. It is difficult to see how disruptive technology will do anything other than exaggerate this trend.
In addition, we are seeing the emergence of an economy in which more and more products are free. Economic theory says price is a function of marginal cost, and marginal cost is often zero in the digital world. A world which sees ever more free products is one in which deflation is a permanent threat.
Two other forces at work may have the effect of pushing down on demand.
The emergence of the sharing economy may mean fewer products can meet our needs. For example, the book iDisrupted predicts that we will see the sharing economy merge with self-driving cars so that within a decade or so few of us will own cars. We will share them instead. This in turn means the world economy will need fewer cars to meet our needs.
The sharing economy will enable us to make a more efficient use of our resources and assets. The inevitable result will be less demand.
Finally, there is the potential impact of technologies, such as robotics and iDisrupted – Artificial Intelligence, on jobs. There is a real danger that we are creating a world in which technology leads to job losses, meaning less demand across the world. This means there will be a permanent shortfall of demand against potential output.